An Explosive Stock Market? You Won’t Read It Elsewhere

By Michael Lombardi, MBA Published : August 6, 2008

The stock market took off like a bullet yesterday with the Dow Jones Industrial Average gaining 2.9% in a single day. Yes, the Federal Reserve met Tuesday and decided to leave interest rates unchanged. And while most analysts were quick to credit the stock market’s advance to comments by the Fed that the economy is still soft (which means it will likely not raise interest rates for some time), my beloved PROFIT CONFIDENTIAL readers know better.

I have been writing for the past few weeks about the stock market being increasingly oversold. Quietly, while almost every newspaper and magazine in this country has been carrying negative news stories on the economy, the Dow Jones Industrial Average has gained 883.81 points since the second week of July. That’s a gain of 8.3%.

Being an avid reader, lately I find it rare to come across a positive story on the economy. You will not find any news story in the columns of today’s major business newspaper talking about the Dow Jones’ 8.3% gain, even though it all happened in less than a month.

As a contrarian, I’ve always done well betting and going against the crowd. And the obvious and strong consensus today is that the U.S. economy is pathetic. But the stock market is telling us a different story. While we read and hear that this is the worse economy in two decades, the stock market is not trading at its bottom — it is rallying from it!

A report I recently read noted that, over a three-year period, from 2004 to 2007, Wall Street investment banks made profits of $250 billion. While this was not a formal study, it was compilation of the profits of the large Wall Street players. As we read elsewhere, investment banks have written off $100 billion so far in what they call bad loans. Hence, the big Wall Street players are still ahead a whopping $150 billion.

In respect to housing, having just come back from Miami surveying the real estate market, I’m becoming more convinced that the real estate market is close to a bottom. The stock market has already discounted the worse for the housing market and the bottom feeders are in like a “dirty shirt” picking up bargains. I’ll have more on this tomorrow.

In the meantime, I am watching one number very closely: the number of shares sold short on the New York Stock Exchange. There are about 18 million shares sold short on the NYSE as of yesterday. When the Dow Jones Industrial Average gains 2.9% in one day you know those short sellers are taking a hit. Should the stock market move higher, many short sellers may be forced to cover (buying back the stock they sold short) and that could really make this an explosive stock market. Surprise!